This Just In: More Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about.

Epic fail: AMD
Pity the poor AMD (NYS: AMD) investor. Just days after thrilling to the news that the semiconductor analysts at UBS had rated the stock a "buy," today those same investors are getting hit by a quadruple-whammy. Not one, not two, but four other analysts have refused to follow UBS's lead and are instead downgrading the stock. Longbow Research just dropped AMD from "buy" to "neutral," ThinkEquity from "buy" to "hold." Meanwhile, Bank of America and Macquarie -- neither of which was much of an AMD fan to begin with, both agreed that the stock's now a clear underperformer and issued downgrades to that effect.

What went wrong? Why the sudden assault of pessimism over AMD? No huge secret here: AMD did it to itself. Late last night, the chipmaker announced that it's cutting guidance on Q3 revenues in half, predicting revenue growth of just 5% versus a previous best guess of 10%. "Yield, ramp, and manufacturing issues" are all plaguing one of AMD's chip fabs, you see, resulting in revenues less robust than hoped for. Gross margins will suffer as well, falling perhaps as far as 44%, versus previous guidance of 47%. And of course, between lower-than-expected revenues, and fewer profits on those revenues, this means earnings are going to come in weak as well. Bank of America, for example, now puts AMD's full-year profit potential at just $0.41 per share -- more than 20% lower than previously forecasted. And the banker sees further damage stretching into 2012, when it could earn perhaps $0.56 per share, another 20% target reduction.

"Told you so"?
Now, I did warn investors not to follow UBS's lead and buy AMD earlier this week, but if you're expecting me to gloat about that -- don't. For one thing, I have no dog in this fight. I'm not short AMD. Never have been. I'm not "long" Intel (NAS: INTC) either. I had no idea AMD's factory problems were brewing, and I had no idea today's downgrades were coming.

What I did know was that AMD had a history of burning cash, which led me to suspect that the company's reported earnings of $828 million for the past 12 months were not as good as they looked. I may criticize rival operators like Skyworks (NAS: SWKS) , Qualcomm (NAS: QCOM) , and Intel for having too-high stock prices. But at least these firms' cash-flow statements prove that they're generating real cash from their businesses, which is a trick AMD has yet to figure out.

What now?
Now you see evidence of AMD's subpar operations, which was first reflected on the cash-flow statement, beginning to show up on the document most investors focus on, the income statement. Now you see proof positive that AMD was never really quite as cheap as it looked. But we have to ask: What would a good cash flow statement at AMD look like? What would AMD have to do to turn me into a bull -- and make the stock worth buying for you?

Well let's see here: At today's prices, AMD has a market cap of $3.7 billion. It's pegged for roughly 10% annual profits growth, which makes the math pretty simple. In an ideal world, AMD would look appropriately priced to me at annual free cash flow of about $370 million, give or take. Up the growth rate, and the free cash flow number could be a bit lower. Up the free cash flow, and AMD could be a "buy" at even sub-10% growth. But ballpark, I'm looking for about $370 million a year in real, cash profits at the company before I buy in.

Foolish final thought
Mind you, hitting this target won't be easy. AMD hasn't managed to generate cash profits at the level I'm targeting since the year 2000. That was the last time AMD exceeded this level of annual free cash flow. I won't hold my breath waiting for the company to achieve a feat it hasn't repeated in nearly a dozen years. I'll instead focus on cheap chip shops showing strong free cash flow, moderate growth prospects, and very reasonable prices. Stock like SanDisk (NAS: SNDK) , NVIDIA (NAS: NVDA) , and Micron (NYS: MU) -- two of which I own, and the third of which I'm strongly considering buying.

At the time thisarticle was published Fool contributorRich Smithowns shares of SanDisk and Micron. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 282 out of more than 180,000 members.The Motley Fool owns shares of Bank of America, Qualcomm, and Intel and has bought calls on Intel.Motley Fool newsletter serviceshave recommended buying shares of NVIDIA and Intel, writing puts in NVIDIA, and creating a diagonal call position in Intel. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.